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Protect Your Retirement From Inflation

A retirement plan that doesn't account for inflation is like a house infested with termites.

Fact: Something that cost you one buck 30 years ago would now cost you $3.57. Put another way, a 1976 dollar could only buy $0.28 worth of stuff today.

If you're still working and earning raises that keep up with, or even exceed, inflation, you're not losing ground in the battle against inflation. If, however, you're retired, then the i-word should be at the top of your list of financial worries.

Bonds are inflation foodThe typical retiree has a good amount of money in bonds. It makes sense: Retirees need income, and bonds pay interest. Plus, their working lives are over (and the fun has just begun!), so they need to protect what they've spent their working lives accumulating.

Here's the bad news about bonds: They do a lousy job of maintaining purchasing power. Assume you bought a $1,000 10-year bond paying 6%. In the first year, you'd receive $60 in interest. A decade hence, after years of rising prices, you'd still just get $60 in interest -- which would buy much less than it did when you bought the bond.

Here's even more bad news for retirees: The 3%-or-so inflation you hear from the government bean counters understates inflation for older folks since health-care costs increase much faster than overall inflation. For example, the monthly premium for Part B Medicare coverage increased 13.2% from 2005 to 2006.

A retirement plan that doesn't account for inflation is like a house infested with termites. Eventually, the thing will fall apart.

Dividends: Inflation-beating incomeSo how does a retiree prop up his purchasing power? By investing in blue-chip, dividend-paying stocks. Gigantic, multinational, brand-leading companies have a wonderful habit: They tend to increase their dividends in good times and bad, at a rate that exceeds inflation. Let's take a look at how the dividends increased for some blue-chip companies over the past decade (a time when inflation grew at an average annual rate of approximately 3%).

Company

10-Year DividendGrowth Rate

Intel(NASDAQ:INTC)

32.7%

Harley-Davidson(NYSE:HDI)

30.7%

Paychex(NASDAQ:PAYX)

28.7%

Home Depot(NYSE:HD)

27.4%

First Data(NYSE:FDC)

23.1%

Nucor(NYSE:NUE)

23.1%

American International Group(NYSE:AIG)

22.7%

Source: Capital IQ

Throw in the potential for capital appreciation and the tax benefits (qualified dividends are taxed at a lower rate than interest), and you have a good protection plan.

Where can you find such companies? You can start by checking out The Motley Fool's latest blue-chip report, 10 Monster Stocks to Anchor Your Portfolio, which is free with a membership to Rule Your Retirement, our premier retirement-planning service.

You want companies that will last as long as you do -- world-dominating businesses that will be around for decades and that have a history of increasing their dividends every year. If possible, keep them outside of your tax-deferred retirement accounts to maintain the lower tax rate on qualified dividends and (assuming you hold on to the stocks for years) long-term capital gains. If those stocks are held in a traditional IRA, for example, the dividends and capital gains will automatically be converted into ordinary income when they're withdrawn from the account, an instantaneous increase in your tax bill.

Inflation-beating income and lower taxes -- what more could you want from a retirement plan?

Robert Brokamp is the advisor of Rule Your Retirement, which you can try free for 30 days. Robert plans to fight his personal inflation by cutting down on soda, ice cream, and chocolate-covered sugar. Home Depot, Intel, and First Data are Inside Value selections. The Motley Fool has a soliddisclosure policy.

Author

As a former financial advisor and English teacher, it was inevitable that Robert Brokamp would one day write about the management of money. His musings on retirement, investments, budgeting, and whoopee cushions can be found on Fool.com and in various other publications, including Better Investing and Newsweek. He was a contributor to The Motley Fool's Money After 40, the co-author of The Motley Fool Personal Finance Workbook, the author of The Motley Fool's Guide to Paying for School, and is the editor of the Motley Fool Rule Your Retirement newsletter service. Robert wishes to one day definitively answer the question, "Why do we make bad decisions with our money when we know better?"
Robert lives peripatetically in Alexandria, Va., with his wife and four children -- but on autumn Sundays he wishes he were in Raymond James Stadium or wherever the Tampa Bay Bucs are battling.